O C T O B E R 2 0 0 2
T E X A S
W O R K F O R C E
C O M M I S S I O N
L A B O R M A R K E T I N F O R M A T I O N D E P A R T M E N T
www.texasworkforce.org/lmi
1
“ A S K T H E E X P E R T ”
“What is the role of consumer confidence in the business cycle, and how does it affect
the economy?” by Professor Jim Lee
Consumers play a major role in the economy. This is because
consumer spending accounts for two-thirds of U.S. output.
Since households’ economic outlook affects their spending
behavior, their expectations influence the direction of economic
activity in the business cycle.
Consumer confidence, or optimism about the overall economy, is
commonly referred to as “animal spirits” after a famous economist,
John Maynard Keynes. Keynes asserted that the Great
Depression of the 1930s was largely attributable to a collapse of
public confidence, which led to dramatic declines in consumer
and business spending.
Today, consumer confidence receives a great deal of media
attention. Rising consumer confidence is widely interpreted as a
precursor to higher future household spending. It is therefore a
leading indicator of the overall economy. If consumers are more
optimistic about the economy, they will tend to spend more,
especially on durable goods and other large purchases. A higher
overall demand for goods and services will subsequently lead to
higher output and employment.
Higher consumer spending, however, may also lead to higher
inflation. For this reason, the Federal Reserve, which seeks to
maintain price stability, also pays close attention to changes in
households’ attitudes toward the economy. The Federal Reserve
may raise interest rates in an effort to reduce any anticipated
pressure on inflation. Since changes in interest rates affect
financial markets, investors also watch closely any signs of change
in consumer confidence.
The two most often cited measures of U.S. public confidence in
the economy are the Confidence Board’s Consumer Confidence
Index and the University of Michigan’s Consumer Sent